Warren Buffett said: “Volatility is far from synonymous with risk”. It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Above all, Wittchen AG (WSE: WTN) is in debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Wittchen
What is Wittchen’s debt?
The image below, which you can click for more details, shows Wittchen owed Z11.2million at the end of September 2021, a reduction of Z38.7million over one year. . However, he has 10.2million z of cash offsetting this, which leads to net debt of around 982.0k z.
A look at Wittchen’s responsibilities
According to the latest published balance sheet, Wittchen had a liability of Z 65.2 million due in 12 months and a liability of Z 47.0 million due beyond 12 months. In return, he had z 10.2 million in cash and z 26.4 million in receivables due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by Z75.5 million.
Wittchen has a market cap of Z303.9million, so she could most likely raise funds to improve her balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt. But in any case, Wittchen has virtually no net debt, so it’s fair to say that she doesn’t have a lot of debt!
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
With debt at 0.02 times EBITDA and EBIT covering interest 25.9 times, it’s clear that Wittchen is not a desperate borrower. Indeed, compared to his income, his debt seems light as a feather. Even more impressively, Wittchen increased its EBIT by 103% year over year. This boost will make it even easier to pay down debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine Wittchen’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Wittchen has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
The good news is that Wittchen’s demonstrated ability to cover his interest costs with his EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Considering this range of factors, it seems to us that Wittchen is quite conservative with his debt, and the risks appear to be well under control. We are therefore not worried about the use of a small leverage on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. We have identified 1 warning sign with Wittchen and understanding them should be part of your investment process.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.